The power of the fear of missing out

May 29, 2015

May 29 (Reuters) – Call it status anxiety, call it greed or
just call it clever momentum trading, but the fear of missing
out is an under-appreciated force in financial markets.

No one likes to miss out on a good thing, especially when
they see their friends, neighbors and rivals cashing in, a
phenomenon three-card-monte dealers have long understood.

There are (at least) two markets right now which show
meaningful signs of attracting capital in substantial part
because of this fear: China’s stock market and Silicon Valley’s
unicorn factory.

In China, which is enjoying a vertiginous market ride
upwards, money is flowing into stocks in part because investors
believe the authorities ‘want’ a bull market and in part because
of media and social media attention fanning the flames.

Bill Janeway, a veteran venture capitalist, sees fear of
missing out, or FOMO, as part of the motive force behind the
rush of private capital into early-stage and more mature but
often still unprofitable tech companies.

“We are in an environment of extraordinary low interest
rates, of enormous quantities of liquidity looking for a
return,” Janeway said in a podcast interview with venture
capital company Andreessen Horowitz. (here)

“There is the phenomenon of FOMO, fear of missing out on the
next Facebook, the next Twitter.”

Venture capitalists are so motivated by the prospect of huge
scores if they identify the next social media or other giant
that they are funding non-public companies in unprecedented
sizes. That’s allowed the advent of Unicorns, the 90 or so
companies with market values of $1 billion or more which have
been entirely funded on the private markets.

Janeway sees reason as well as fear behind the behavior,
with investors taking multiple bets, each with a relatively low
probability of success, but hoping for outsize returns from the
very few which do succeed. Which is different, of course, from
saying that the mass of funds put into these companies will
collectively earn a respectable return.

In China, the more than doubling in the Shanghai stock
exchange has attracted legions of new investors. Shanghai stocks
fell 6.5 percent on Thursday, however, and ended Friday little
changed after an early 4 percent drop.

New equity trading accounts rose 433 percent in the first
quarter from a year earlier, according to official data, with
more than half the accounts set up by investors aged up to their
early 30s. The China Household Finance Survey found that more
than two thirds of the new investors in equities had not
completed high school.

FOMO

Much of this may be driven by concerns about relative
wealth, or how much you have compared to those in your group, a
force explored in a 2007 paper by Peter DeMarzo and Ilan Kramer
of Stanford University and Ron Kaniel of Duke University. (here)

They found that even when traders understand that prices are
too high they may stay in the market because they fear losing
out as the overvaluation persists and extends.

“Relative wealth concerns help support the existence of
financial bubbles by increasing the risk of trading against the
crowd,” the study found.

“When relative wealth concerns are sufficiently strong, they
can promote the creation of price bubbles.”

Investors want to keep pace with their peers, and fear not
having as much wealth. That raises, in a certain way, the risk
of selling into a bubble. That status and group-motivated
anxiety can blind investors towards other, seemingly obvious
risks.

In some ways this seems to be more likely to happen in
micro-climates like Silicon Valley than in a large economy like
China. After all, the huge influx of wealth has driven up the
cost of most things people would like to buy, like houses, in
Silicon Valley, while at the same time recalibrating upwards
expectations about what constitutes an acceptable standard of
living.

That is perhaps less true in China where the amount of
wealth being generated is far smaller in relation to the
economy. This is true, so far as it goes, but investors often
get their expectations and sense of what is normal from
communities, online or in real life. In these communities, tall,
or true, tales of gains serve to drive further investors into
risky assets and to make them less sensitive to risks.

Janeway makes a larger point: that often these types of
bubbles produce transformative technologies that otherwise would
not come into being as quickly.

Just as people lost money in railroad shares in the 19th
century, or radio stocks in the 1920s, so did the railroad and
radio transform modern life.

“The way to think about financial speculation is that
bubbles are banal but every once in a while they are necessary.”

A better strategy might be to put aside fear of being left
behind and enjoy the changes the bubbles finance.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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